Making Note of Important 401k Rollover IRS Rules

The 401k was born of a small section of the IRS code (section 401k), but it was actually a banker, not the IRS, that created the concept of the program. Using the technicalities of the code, one bank president set off a revolution in modern retirement saving dating back to 1980.

As popularity of the concept spread, the IRS faced the necessity to “update the books” and write new laws that made the 401k advantageous for government, business, and savers, while preventing tax evasion and promoting proper personal finance strategies. Some of the most aggressive changes have been made more recently from 2000-2011, with the 401k rollover IRS rules being some of the most variable laws on the books.

401k Rollover IRS Rules: 2005 Minimum Distribution and Qualifications

In 2005 the rules for 401k rollovers to an IRA were bent once more. The law, passed in 1998 but offset with a late state in 2005, was designed to change rules as they relate to accepting IRA distributions. Since IRAs require minimum distributions in a Roth IRA, this law makes the IRA distribution amount virtually meaningless as it relates to your ability to qualify for a rollover to a Roth IRA.

The minimum distribution is still required, and taxes are to be paid on this distribution, however, it is not a qualifier in one’s ability to transfer from a 401k to a Roth IRA. Thus, the net effect is that following the passage of this section of the 401k rollover IRS rules, more people could quality for a rollover than ever could before. Starting after 2010, there is no income limit on conversions.

Effectively, one could save almost entirely in a traditional IRA (available to anyone without income restrictions) and then convert it to a Roth IRA, even though they cannot contribute directly to a Roth IRA. This is true for traditional 401ks, as well.

401k IRS Rules

401k Rollover IRS Rules: 2008 Changes to Employer Rollovers

The Pension Protection Act passed in 2006 went in effect in 2008. This massive change to the conversion and rollover process made rollover of a 401k account to Roth IRA far easier, as it removed a redundant step.

Before this 401k rollover IRS rule was enacted, employer sponsored retirement plans had to be first rolled into traditional IRAs before a conversion from traditional IRA to Roth IRA could be made. This three step process required additional paperwork, time, and unnecessary steps that some found to be too large to bother completing. As a result, many retirement planners opted to invest only in their 401k, since movement to a Roth IRA was so time-consuming.

Keep in mind, though, that movement to a Roth IRA from a 401k can be done only by one large jump, and regular contributions into a Roth IRA are still disallowed for those who exceed the income limits. These income limits for 2011 are $169,000 for married couples, with phase-out at $179,000. For single head of households, the limits are $107,000, with phase-out through $122,000.

Planning Your Conversion

Unfortunately, the best window for conversion of pre-tax accounts to post-tax Roth accounts is now closed. In 2010, those who completed such transfer could spread the resulting tax burden over two years. In 2011, however, those who wish to convert will have to pay the full tax burden in one year.

For more information on 401k rollover IRS rules, consider reading about the Pension Protection Act and RR98.
Tim Ord
Ord Oracle

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